Reports from the Moscow headquarters of United Company Rusal, indicated last week that in an arrangement with Glencore Xstrata, large volumes of unsold metal are being stocked off the market in Estonia and other locations, and are not counted in the worldwide stockpile count of the London Metal Exchange (LME). The reports began here; the impact of last week’s US investigations was reported here.

In trading of Rusal shares on the Hong Kong Stock Exchange over the month of July, the share price has slipped almost 16%, and is now below HK$2.70 for the first time ever. The company’s market capitalization is now $5.2 billion – that is half the total of the loans and borrowings Rusal reports as owing on March 31.
The investigation of what Rusal reports in volume and value of its aluminium sales, and the prospect of uncounted stocks of aluminium threatening the future metal price, and in tandem Rusal’s share price, have challenged the partnership between Rusal chief executive, Oleg Deripaska (right), and Ivan Glasenberg of Glencore (left), to be conserving future value for the company. Traders close to Glencore’s aluminium operations have come out of the woodwork to describe what they know of this partnership, the volume of aluminium it is hiding off market at present, and who benefits most. As a result, these sources, requesting anonymity, claim that Glencore now dominates Rusal management, and decides what is reported on its balance-sheet.

According to these trade sources outside Russia, more than a million tonnes of aluminium may now be in off-market stockpiles. That represents one in tonne in four of the total Rusal says it produced in 2012 (4.173 million tonnes). When Rusal reports its periodic financial results, the revenue line indicates what value its sales produce, not exactly what tonnage of metal has been sold.

Rusal’s annual report for last year avoids saying how much aluminium is delivered to Glencore, stocked, or sold. Look carefully: “Commitments include sales to Glencore in accordance with a recently concluded long-term contract for which the sales volumes will depend on the actual production in 2013-2018. The volume of sales commitments to Glencore for 2013 year under the agreement is specified and is estimated to be from USD3,253 to USD3,386 million.”

Rusal’s latest financial report, issued in May for the quarter ending March 31, 2013, claims that part of the reason for the modest increase in its sales revenues for the period was the premium which consumers are willing to pay for on-time delivery of metal out of warehouse. “Revenue in the first quarter of 2013 increased to USD2,682 million (by 2.2%) as compared to USD2,624 million for the fourth quarter of 2012 due to historically high premiums over LME aluminium price of USD264 per tonne and improvement of the product mix offsetting a 1.7% decrease in physical aluminium sales while the metal price on LME was almost flat as compared with the last quarter of the preceding year.”

According to the report, Rusal says it produced 1,007,000 tonnes of aluminium for the quarter – 4% less than in the December quarter. The company also reports selling 994,000 tonnes of something ever so slightly different – “primary aluminium and alloys”; that volume was down 9.2% on the previous period. This suggests that 13,000 tonnes have disappeared, unsold for the time being. The sale figure in dollars would be barely above the cost of production in the accounting, so the profit, if Rusal makes any on its sales, depends on the “premium”. There is no defining what that is, except that it is reported as $269 per tonne above the LME price; the premium was 6% above the December quarter, and 60% above the first quarter of 2012.

Meaning: without the “premium” Rusal would be unable to sell the aluminium it produces at a profit. But what if the premium belongs, according to the Rusal contracts with Glencore, to Glencore? Rusal’s last annual report says: “Aluminium premiums will continue to grow in 2013”. What if they don’t?

According to a trader who has pored through Rusal’s accounts, “it is not possible to deduce which income is from the two parts to the aluminium price – the LME flat price and the premium payable for on-time delivery out of warehouse. You would need to have separate accounting for the two parts for it to make sense. It is however clear that one party, most likely Glencore, accounts for about 40% of total sales.”

Estonian warehousing of the metal sold or unsold is convenient, says a source, “because it is connected by rail to the Russian smelters and also has good connections to other ports. Thus it is not necessary to load or unload the metal many times, incurring additional costs. It can then be transported from Tallinn to any end destination.” This is not the first time Glencore has been doing this. “This happened during the collapse of the Soviet Union when there was a glut of aluminium coming out of Russian smelters,” another source reports.

Here then is a compilation of what aluminium traders say is happening to Rusal metal once it crosses the Russian frontier and disappears.

“With regard to the stock developments we have to go back to the start of the financial crisis at the end of 2008. It was during this time and the subsequent years when the queues and large stocks for aluminium started to form. Producers faced a collapse in demand and prices, putting pressure on their cash flow and profitability. Simultaneously large contangoes formed on the LME; basically, that is where the forward price is higher than the cash price. These allowed traders and banks to borrow forward on the LME, at levels much bigger than the cost of holding the metal on stock. By forward borrowing in early 2009 what was meant was terms of several years up to five years or so.

“This enabled the LME warehouses to absorb the excess stock in the market place and provide producers with the necessary liquidity to keep them operational. Premiums at that point were very low. By locking in finance agreements the excess stock was taken out of the market place and put aside for several years. But when consumption started to improve, there was no stock available and all new sales had to be supplied out of new purchases, pushing the premiums higher. Also, it did not make sense to break the storage and finance agreements already in place, because they were usually locked in for a fixed period; breaking them had significant costs attached. Usually they are renewed with the banks in form of a repo transaction.

“The cost of holding metal is a function of finance cost (interest rates), warehouse storage charges and insurance. So, for example, if you can get $10 contango on the LME, but your total cost is only $5 per month, then you can see that it makes more sense to lock up the metal for several years and earn profits without doing very much.

“It is not necessary to hold stock in an LME warehouse. Any location will do as long as it is secure. Thereby instead of earning the LME rent (via ownership of the warehouse) one can agree on long- term storage with a warehouse which will accept a lower rent compared to LME storage.

“By agreeing a long-term contract with Rusal, Glencore has effectively taken this metal out of the market and will start distributing it when the market recovers. Because the premiums have been fixed (the contracts are secret, so this isn’t certain) Rusal will probably will not profit from the premium upside. On the other hand, Rusal would not have been able to do this stocking on their own. So this puts Glencore in a very strong position. You end up having a situation where the tail wags the dog, which is the downside of the agreement for Rusal.”